Determinants of Currency exchange rates USD to PKR Part-III

Currency exchange rates
Currency Exchange Rates USD to PKR

CURRENT ACCOUNT DEFICITS

The current account is one of three components of a country's balance of payments system that influences the determination of currency exchange rates. It is the country's trade balance, or the balance of goods and services imports and exports, plus earnings on foreign investments minus payments to foreign investors. The capital account and the financial account are the other two components. It is also a metric for all international capital transfers. A deficit in the current account shows the country is spending more on foreign trade than it is earning from trade, hence forced to borrow capital from foreign sources to cover up the deficit. In other words, the country requires more foreign currency than it receives through sales of exports. Exports are demand for the local currency of exporting country currency (as importers will require exporting country currency to buy the goods and services of the exporting country), whereas imports are demand for foreign currency of importing country currency (as exporters will sell their goods & services in their currency). 

The excess demand for foreign currency lowers the country’s exchange rate until domestic goods and services are cheap enough for foreigners and foreign assets are too expensive to generate sales for domestic interests. Analysts and currency experts witnessed a smooth fall in the value of the local currency against all major international currencies. particularly US dollar, believe that falling reserves and rising current account deficit have a direct relationship with the exchange rate regime. The current account is defined as the difference between the value of goods and services exported and the value of goods and services imported. A current account deficit indicates that the country is importing more goods and services than it is exporting—though the current account also includes net income (such as interest and dividends) and transfers from abroad (such as foreign aid), which are typically a small portion of the total.

The difference between national (both public and private) savings and investment can also be expressed as the current account. A current account deficit may thus indicate either a low level of national savings relative to investment or a high rate of investment—or both. A current account deficit may be natural for capital-poor developing countries that have more investment opportunities than they can afford to pursue due to low levels of domestic savings.

If the deficit reflects an excess of imports over exports, it may indicate competitiveness issues; however, because the current account deficit also implies an excess of investment over savings, it may also indicate a highly productive, growing economy. If the deficit is the result of low savings rather than high investment, it could be the result of reckless fiscal policy or a consumption binge.

Pakistan's current account posted a massive $632-million deficit in May 2021, compared to a $329-million surplus in May 2020, according to the State Bank of Pakistan (SBP), marking the highest monthly deficit since December 2019.

PUBLIC DEBT

Foreign investors are less interested in countries with large public deficits and debts. The reason for this is that a large debt encourages inflation, and if inflation is high, the debt will be serviced and eventually paid off with less expensive real dollars in the future. In the worst-case scenario, a government may print money to pay off a portion of a large debt, but expanding the money supply inevitably leads to inflation. Furthermore, if a government is unable to service its deficit through domestic means (sale of domestic bonds, increase in the money supply), it must increase the supply of securities available for sale to foreigners, lowering their prices. Finally, if foreigners believe the country is about to default on its obligations, a large debt may cause concern. If the risk of default is too high, foreigners will be less willing to own securities denominated in that currency. As a result, the country's debt rating (as determined, for example, by Moody's or Standard & Poor's) badly effect and exchange rate.

According to World Bank estimates, the fiscal deficit widened year on year in the first six months of FY21, as expenditure growth outpaced revenue growth. Total revenues increased by 3.7 percent, in line with the recovery of economic activity. Over the same period, total expenditures increased by 6.2 percent, owing in part to higher interest payments. At the end of December 2020, public debt, including guaranteed debt, stood at 87.9 percent of GDP, up from 86.7 percent at the end of December 2019.

Moody's confirmed Pakistan's B3 credit rating with a stable outlook as part of a review for downgrade, according to a statement from the agency. The statement made it clear that the rating agency is closely monitoring the government's actions in its effort to seek debt relief, with a particular emphasis on whether or not the government will seek debt relief from private creditors at some point in the future. “The stable outlook reflects Moody's view that the pressures Pakistan is facing in the aftermath of the coronavirus shock, as well as prospects for its credit metrics in general, are likely to remain consistent with the current rating level,” according to the statement.

TERMS OF TRADE

The ratio of the index of export prices to the index of import prices is defined as the terms of trade. If export prices rise faster than import prices, a country's terms of trade improve because it can buy more imports for the same amount of exports. TOT = (Index of average export prices / Index of average import prices) x 100

If export prices rise relative to import prices, we say the terms of trade have improved. A unit of export buys more imports than a unit of import. In general, this raises living standards by making imported goods appear cheaper to consumers.

When import prices rise relative to export prices, we say the terms of trade have deteriorated. In general, this lowers living standards because foreign currency earnings are lower and imported consumer goods are more expensive.

Pakistan's terms of trade fell to 61.80 points in the first quarter of 2021, down from 65.10 points in the fourth quarter of 2020. State Bank of Pakistan is the source of this information.

POLITICAL STABILITY AND ECONOMIC PERFORMANCE

Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw investment funds away from other countries perceived to have more political and economic risk. We can't survive without economic growth. In order for economic growth to occur, we also need political stability. Political instability, high inflation, and slow growth are all first cousins. Pakistan's current status quo consists of three components: extreme political uncertainty, high inflation, and low economic growth. This status quo can only be maintained at great economic cost. Pakistan requires governments that prioritize economics over politics. Pakistan requires governments that prioritize political reconciliation over conflict. Pakistan requires governments that are doers rather than just propagandists.

Conclusion

Rates in a fixed exchange rate regime Currency exchange rates are determined by the government, whereas rates in a floating exchange rate regime are determined by market forces. Interest rate parity other theories though provide a logical explanation for exchange rate fluctuations; however, they fall short because they are based on dubious assumptions (e.g., free flow of goods, services, and capital) that rarely hold true in the real world. The balance of payments model is primarily concerned with tradable goods and services while ignoring the growing importance of global capital flows. It failed to explain the dollar's continuous appreciation during the 1980s and most of the 1990s, despite the US's soaring current account deficit.

The supply and demand for any given currency, and thus its value, are influenced by a combination of factors. These elements are classified into three types: economic factors, political conditions, and market psychology.

Hopefully, readers will be able to grasp the core idea of how, for example, Currency exchange rates USD to PKR are determined.

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